Does the debt from your college days seem overwhelming? You're not alone: Student loans in the U.S. total more than $1.6 trillion. That's second only to the size of the nation's mortgage debt.
Ironically, the burden of student loans is making it harder for college graduates to buy a home. Politicians are debating what to do about the problem, but in the meantime, individual Americans can't wait around for them to work it out.
Developing a plan to manage your student loans is critical to your long-term financial health. We explore 10 steps to help you get control.
- Developing a plan to manage your student loans is critical to your long-term financial health.
- Know how much you owe and the terms of your loan contract(s), review the grace periods, and consider consolidating your debt if it makes sense.
- Pay off the loans with the highest interest rates first as you tackle your debt.
- Paying down your principal balance and paying your loans automatically can help you reach your goals faster.
- Explore alternative plans, deferment, and loan forgiveness (or discharge) to help you along the way.
1. Calculate Your Total Debt
As with any type of debt situation, the first thing you need to understand is the overall amount you owe. Students usually graduate with numerous loans, both federally sponsored and private, having arranged for new financing each year they were in school. So buckle down and do the math. Only by knowing your total debt can you develop a plan to pay it down, consolidate it, or possibly explore forgiveness.
2. Know the Terms
As you sum up the size of your debt, also itemize the terms of every loan. Each one could have different interest rates and different repayment rules. You'll need this info to develop a payback plan that avoids extra interest, fees, and penalties.
The Department of Education offers Federal Student Aid, which is an online resource designed to help students find their best repayment plans and manage their loans.
3. Review the Grace Periods
As you pull together the specifics, you will notice that each loan has a grace period. This is the amount of time you have after graduation before you have to start paying your loans back. These can also differ. For example, Stafford loans have a six-month grace period, while Perkins loans give you nine months before you have to start making payments.
To provide economic relief from the COVID-19 pandemic, the U.S. government suspended all payments and interest on federal student loans through Dec. 31, 2022.
4. Consider Consolidation
Once you have the details, you may want to look at the option of consolidating all your loans. The big plus of consolidation is that it often reduces the burden of your monthly payments. It also frequently lengthens your payoff period, which is a mixed blessing. Remember, it may give you more time to pay the debt, but it also adds more interest payments too.
What's more, the interest rate on the consolidated loan may be higher than what you're paying on some of your current loans. Be sure to compare loan terms before you sign up for consolidation.
There is one crucial factor you should keep in mind. If you consolidate, you lose your right to the deferment options and income-based repayment plans that are attached to some federal loans. We outline some of these below.
5. Hit Higher Loans First
As with any debt-payoff strategy, it is always best to pay off the loans with the highest interest rates first. One common scheme is to budget a certain amount above the monthly required payments, then allocate the overage to the debt with the biggest interest bite.
Once that is paid off, apply the total monthly amount on that loan (the regular payment, plus the overage, plus the regular amount) towards repaying the debt with the second-highest interest rate. And so on. This is a version of the technique known as a debt avalanche.
For example, suppose you owe $300 per month in student loans. Of that, a $100 payment is due to a loan with a 4% rate, $100 is due to a loan with a 5% rate, and $100 is due to a loan with a 6% rate. You would plan your budget with $350 to pay off your student loans every month, applying the extra $50 to the 6% loan.
Once it's paid off, take the $150 used to pay the 6% debt each month and add it to the $100 being used to pay the 5%, thus paying $250 each month for the loan with a 5% rate and speeding up that payoff. Once you wipe off that loan, then the final loan at 4% would be paid at the rate of $350 per month until all student debt is paid in full.
6. Pay Down Principal
Another common debt payoff strategy is to pay extra principal whenever you can. The faster you reduce the principal, the less interest you pay over the life of the loan. Since interest is calculated based on the principal each month, less principal translates to a lower interest payment.
7. Pay Automatically
Some student loan lenders offer a discount on the interest rate if you agree to set up your payments to be automatically withdrawn from your checking account each month. Participants in the Federal Direct Loan Program get this sort of break (only 0.25%, but hey, it adds up), for example, and private lenders may offer discounts as well.
Note that the American Rescue Plan, President Biden's stimulus package addressing the COVID-19 pandemic, includes a provision that makes all student loan forgiveness from Jan. 1, 2021, to Dec. 31, 2025, tax-free.
8. Explore Alternative Plans
If you have a federal student loan, you may be able to call your loan servicer and work out an alternative repayment plan. Some of the options include:
- Graduated repayment: This increases your monthly payments every two years over the 10-year life of the loan. This plan allows for low payments early on by accommodating entry-level salaries. It also assumes you will get raises or move on to better-paying jobs as the decade progresses.
- Extended repayment: This allows you to stretch out your loan over a longer period of time, such as 25 years rather than 10 years, which will result in a lower monthly payment.
- Income contingent repayment: This calculates payments based on your adjusted gross income (AGI) at no more than 20% of your income for up to 25 years. At the end of 25 years, any balance on your debt will be forgiven.
- Pay as you earn: This caps monthly payments at 10% of your monthly income for up to 20 years if you can prove financial hardship. The criteria can be tough, but once you’ve qualified, you may continue to make payments under the plan even if you no longer have the hardship.
While these plans and other repayment options may well lower your monthly payments, bear in mind that they may mean you'll be paying interest for a longer period, too. They also aren't applicable to any private student loans you took out.
9. Defer Payments
If you are not yet employed, you can ask your student loan lender to defer payments. If you have a federal student loan and you qualify for deferment, the federal government may not charge you interest during the approved deferment period.
If you don’t qualify for deferment, you may be able to ask your lender for forbearance, which allows you to temporarily stop paying the loan for a certain period of time. With forbearance, any interest due during the forbearance period will be added to the principal of the loan.
10. Explore Loan Forgiveness
In some extreme circumstances, you may be able to apply for debt forgiveness (also sometimes called cancellation) or the discharge of your student loan. You could be eligible if your school closed before you finished your degree, you become totally and permanently disabled, or paying the debt will lead to bankruptcy (which is rare).
In August 2022, President Biden announced student loan relief for eligible borrowers. Individuals whose income is less than $125,000 ($250,000 for couples) and who received a Pell Grant at school are eligible for debt cancellation up to $20,000. For those that did not receive a Pell Grant, they are eligible up to $10,000.
Another less drastic but more specific option is that you have been working as a teacher or in another public service profession.
How Do You Manage Student Loan Debt?
Some ways to manage student loan debt include paying more than your monthly bill, sticking to a budget, considering consolidating/refinancing, looking into loan forgiveness, and exploring different payment programs.
What Happens if You Don't Pay Off Your Student Loans?
Not paying off your student loans is extremely damaging to your credit profile. Not paying off your student loans is the same as not paying off any other loan; your loan will be considered delinquent, go to a collection agency, go on your credit report, and negatively impact your credit score. This will make it harder to borrow in the future, which includes getting a car loan or a mortgage. For federal student loans that are not paid off, the government can garnish your wages and withhold your tax refunds.
What Is the Average Student Loan Debt?
The average student loan debt in the U.S. in 2022 for federal student loans was $37,358.
The Bottom Line
Not all these tips may bear fruit for you. But there's really only one bad option if you are having difficulty paying your student loans: to do nothing and hope for the best. Your debt problem won't go away, but your creditworthiness will.